Coal is not only the leading contributor to atmospheric CO2 levels, it is the most financially dangerous investment. Coal prices have plummeted. Between 2010 and 2014, three coal plants were delayed or scrapped for every one built. After being dropped from Standard and Poor’s 500 Index in September, Peabody Energy, the world’s largest private sector coal firm, was dropped from Standard & Poor’s MidCap Index last week because its market cap has plunged from $3.9 billion to just $700 million.

Other recent developments have made the idea of stranded fossil fuel assets far more tangible. These have included the G20 conference asking for an investigation into $6 trillion in planned fossil fuel extraction investments, the wholesale divestment from coal by the Norwegian Pension Fund, and the International Monetary Fund’s repeated calls for an end to fossil fuel subsidies.

So far, the Big Three rating agencies have ignored all this — just as they, along with the rest of Wall Street, ignored both common sense and strong evidence that housing prices would not rise forever.

'... key enablers of the financial meltdown. The mortgage-related securities at the heart of the crisis could not have been marketed and sold without their seal of approval. Investors relied on them, often blindly. In some cases, they were obligated to use them, or regulatory capital standards that were hinged on them. This crisis could not have happened without the rating agencies.'

Now the agencies are again playing the role of the blind leading the blind, relying on the assumption that no steps will be taken to reduce fossil fuel reliance, and that a warming world won’t interfere with business as usual.

CIEL writes:

'Many in the finance industry continue to rely on the current ≥4°C climate scenario (a “carbon bubble”), just as many relied on scenarios where housing prices did not decrease or stabilize. Indeed, the financial risks of a 2°C climate scenario loom large, just as the risks of sub-prime mortgages loomed over the financial industry prior to the credit crisis. Some analysts project that the fossil fuel industry could lose $28 trillion USD of revenue over the next two decades. Recently, the Bank of England’s Finance Policy Committee announced that it will investigate whether the carbon bubble could lead to a financial collapse.'

[The 4-degree scenario is one in which no measures are taken to restrict warming to 2 degrees.]

To nail down how wrong-headed the ratings system can be, CIEL looks at Moody’s decision in the fall of 2014 to give a Baa3 rating, which is investment grade, to the $150 million in bonds issued to finance the Adani Abbot Point Terminal, a port facility that will be part of the massive Australian Galilee Basin system of mines and rail lines designed to get Australian coal to Asian markets. Dubbed a “carbon bomb” by environmentalists, Galilee coal will create substantially more CO2 each year than Australia’s entire current annual greenhouse gas emissions.

The Adani situation is a neat microcosm of the entire problem with the Big Three’s approach to carbon — or rather, its lack of an approach. Moody’s used a generic project finance methodology to assess the investment risk, the same method it uses for non-carbon intensive projects, such as parking garages. That methodology assigns only 15 per cent weight to exposure to event risk, 25 per cent to long-term commercial viability and a whopping 60 per cent to cash flow stability.

And Moody’s vastly overvalued the price Adani coal will fetch on the market — $84/ton when prices at the time of rating were just above $70. And India, where Adani plans to sell most of its coal, six coal plants have been postponed or dumped for every one built, while the government has announced plans to vastly upscale its use of renewable energy.

This is all in addition to the likelihood of major disruptions to mining operations from a spike in extreme weather events along the Australian coast, such as more ferocious cyclones, high temperatures, and heavy rainfalls that can flood the mines, shutting them down for months.

All of which could lead the rating industry back to one of the ugliest moment in its legal history.

Following the 2008 crash, large institutional investors – most notably, CalPERS (California Public Employees Retirement Systems) – sued the rating agencies. In the CalPERS case, filed against Moody’s, the court brushed away the agencies traditionally successful defenses, and approved the suit going forward on the basis of a negligent misrepresentation claim. The CalPERS appellate court opinion quoted an expert who said the ratings agencies 'had no empirical or logical basis of assumption' for the ratings it gave to the financial products CalPERS purchased.

Moody’s settled — a development that would have been almost impossible to conceive a few years earlier.

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Independent Australia is a progressive journal focusing on politics, democracy, the environment, Australian history and Australian identity. It contains news and opinion from Australia and around the world. [ read more ]